The ADU Gold Rush: How Investors Are Creating Wealth with Backyard Housing

Seth Phillips (00:00)
And that formula works out pretty good. And that’s really the gold at ADU Gold because in California, ⁓ we have some of the most expensive real estate in the country. And that all boils down to a cost per square foot.

And in Los Angeles right now, for instance, the median value per square foot of sales of single-family homes is over $600 a square foot. Now we get to the magic part of the math. The construction costs are also quite expensive and higher in California than most parts of the

Scott Bursey (02:17)
Welcome back to the Real Estate Pros podcast powered by Investor Fuel. I’m your host Scott Bursey. Today we’re diving deep into one of the hottest strategies in real estate, accessory dwelling units or ADUs. Our guest, Mr. ADU himself, Seth Phillips, founder of ADU Gold. If you’re looking for strategies on maximizing density, increasing cash flow,

and navigating the future of housing, you’re about to get a massive injection of high octane fuel. Seth brings the blueprint for scaling ADU projects. Fasten your seat belts, you’re going to want to hear this one. Seth, welcome to the show.

Seth Phillips (02:56)
Thank you so much, Scott. I really appreciate it.

Scott Bursey (02:59)
It’s awesome having you here and for our listeners who may not be familiar with your journey, please tell us, how did your career begin and what is your main focus now?

Seth Phillips (03:08)
Thank you very much. My name is Seth Phillips, also known as Mr. ADU.

I’m originally from Minnesota you betcha and you’ll still hear a little bit of that in my voice, but I’ve lived in Los Angeles for over 38 years now and I’ve been a real estate agent broker for over 35 years now in Los Angeles and I really enjoy being a realtor and I was doing that full-time for a very very very long time until all the

sudden in 2006 something happened and it’s just like it happened so suddenly because that’s when the market crashed because of the big financial crash.

And it’s so weird because I went from having a job that I really enjoyed that paid me very well to basically being virtually unemployed overnight. So I was looking around for what else I could do while the market was hopefully going to heal and decided to go into the house flipping business. And this wasn’t that long ago, but we were buying homes at the courthouse step.

in Los Angeles for $120,000, fixing them up and then selling them for $180,000. Well, anybody that’s done any house flipping knows that by the time you get done with your fix-up costs, your holding costs, your buying costs, your selling costs, with those kind of numbers, you’re not going to have much profit left at the end of the day. Some, but not much.

So we had to then learn another skill set and that was how to manage multiple projects at the same time. So we scaled that up and we were typically doing about 10 to 12 projects at the same time. That was making us some money. But we had to learn new skill sets to manage all that kind of workflow too, which was very helpful. Then as the market just slowly began to heal, we just started to flip homes and more and more expensive.

of neighborhoods until we got all the way to the very top of that food chain where we were now doing completely ground up new construction in the ultra luxury segment of the market. And we’re talking about homes in Beverly Hills, Bel Air, Hollywood halls. And of course, those homes weren’t selling for 180,000. They were selling for $10 million. But those kind of projects are so complicated

that from the time you start, and we were spec builders, so we were having to pay millions of dollars for the dirt, millions of dollars for the construction, and then those projects, as I said, are so complicated that from the time you start to the time you can bring it to market is like two years.

Well, a lot can go wrong in two years. And because we respect building, we had all that money out on the table. So.

We’d already now been in an upward appreciating market for a while and knowing that in real estate, like most things in the financial world, it moves in cycles. You know, sometimes it’s moving up, sometimes it’s moving down. And as a spec builder with multi-million dollar bet on the table, you don’t want to be caught on the wrong end of that particular cycle thing. So.

We decided to just be more careful. So we scaled back and we decided to build our next project in a less expensive area, a nice area of Los Angeles Culver City. And then just to do what we had been doing, which is just knock down the existing fixer upper house and then just build a big two story modern box on it. So we found a property that we purchased at actually a probate sale in Culver City

for $735,000 with the intention of just knocking it down and building a nice new beautiful two-story box on it.

So we hired the architect and then I had my aha moment and everybody’s had, you know, some kind of big thing happen in their life and they remember that thing for the rest of their life. sometimes you have a moment that’s so profound that not only do you remember the thing, but you remember everything about the moment that thing came into your head. And I remember this moment and I always will. I was sitting in the

car

in the passenger seat. My business partner and I were driving out to look at some more properties and all of sudden he started telling me about this new ADU law that had just gone into effect into California. And there was something just about that that was so profound that I remember everything about that. I remember looking out the window at the hill on the side of the car. I remember the dashboard. I remember the sound of his voice talking to me about it.

It was just hit me so profound that I immediately deep dived into it and the more I studied it and the more I researched it the more I just came to believe that this was going to be a very important part of the future of real estate in California so I was able to convince my business partner to Completely abandon our original plan which was not easy because we had just spent thirty thousand dollars on a set of architectural plans

that had just been completed. But instead of knocking that house down, we instead just kept the house and beautifully remodeled it. And then in the backyard, we built the first two story with rooftop deck ADU in the city of Los Angeles. And I’m very happy to say that that worked because we bought that property, as I said, for 735,000.

And we sold that property for 1,805,000. And in the process of doing that, we learned one and probably the most important lesson about ADU construction. And the question that everybody asks is how much value does an ADU add to your property? And, you know, in front of this project, I was the one that was

you know, responsible for putting together the projections on how we thought this would perform.

And that was not easy to do because at that point there were no properties to compare it to. Nothing, ADUs had just started to be built. So there was no comps to look at. So I had to come up with a formula for that and I settled on the simplest of all and I firmly still believe this and now statistically there’s so many of them out there it’s been proven is that your ADU should add to your

property and value the same amount per square foot as what’s on your property right now. And I took that from a simple thing that a lot of people first time buyers trying to get into the market. They have to buy a small inexpensive house just to get into the market. So very typically they might buy a two bedroom one bath home that’s somewhere in the neighborhood of say

thousand square feet and they get in and that works and they’re young and they start to grow family and then next thing you know they’ve got children and they’re feeling they’re really cramped in their house. So traditionally what’s happened is that people then just sell that house and go buy a bigger house and they still do that but sometimes people

consider instead of that because they love their neighborhood. They love their neighbors and they don’t want to move. So instead they take that two bedroom one and bath house and they’ll add a master bed and bath to it. So now it’s a three bedroom two bath house. And when you do that, generally speaking, whatever your house is worth per square foot will now be worth that same amount per square foot, but it’s now a bigger house.

And that formula works out pretty good. And that’s really the gold at ADU Gold because in California, ⁓ we have some of the most expensive real estate in the country. And that all boils down to a cost per square foot.

And in Los Angeles right now, for instance, the median value per square foot of sales of single-family homes is over $600 a square foot. Now we get to the magic part of the math. The construction costs are also quite expensive and higher in California than most parts of the country.

for a sort of mostly bureaucratic reasons, but they’re more in response to just building more quality housing that’s going to be resistant to all kinds of natural disaster things, including earthquakes, of course. So construction is expensive and it’s going to cost about $300 a square foot to build new construction, residential construction in California. That’s a lot of money, but this is the formula.

It costs $300 to build, but it delivers $600 a square foot in value. That is a good investment every time.

And that really brings up the number one thing that ADUs offer as a incentive for people is that you get to now build a separate legal living unit on free land. Well, it could be free. Well, it’s free because you already own the land. That cost has already been spoken for.

So now you’re truly just looking at this decision from that simplest of all mathematical equations. It costs you $300 a month to build it and it’s going to deliver you $600 a square foot in value. So it’s going to double your investment right out of the gate. And then of course you’ve got the opportunity to for what ADUs are used for all kinds of reasons. But one of the big ones of course is to rent it out.

for additional income and that rental unit will also deliver incredible rents because this is a kind of product that people love to live in. It’s like their own house. They’re going to be in back of another house, but it’s their own house, which is in most people’s mind, much more desirable than living in an apartment in an apartment building, for instance. So it’s going to deliver you great value from a rent perspective.

It’s going to bring you great value from an equity perspective and that was just the beginning of the journey but that still is the bedrock and that’s of course just there’s been now over a hundred thousand permits pulled for ADUs in the state of California. So the whole reason that they came up with these laws is because we have a housing shortage in California and that’s not unlike it is actually in many big cities.

across the country because you know when you figure when they create a city if you go back in a successful city there’s typically not much in the way of any empty land anymore it’s already been developed so where are you going to add more well

California was kind of a leader in this suburbia development thing. So as LA grew, it was very simple. They just started to build stuff further and further away from the center of the city. But now we’ve got it to where it’s so spread out that we have people that are living on the outskirts of the city that are driving up to two hours a day each way to and from work.

And that means they’re spending all that time on freeways in traffic in the pollution that that all causes. It’s just it’s just not a practical good way to live. So we can’t just keep spreading out. We have to find ways to increase densities in the city. And that’s what these cities did. These new laws did is they increase the density potential for being inside of cities.

to promote the construction of more housing units which we desperately lead and now it’s actually starting to work and now there are last I checked there are now ADU laws at least in parts of I believe we’re up to now 37 states have some kinds of ADUs on the books right now so it’s a not just a California thing it’s it’s everywhere in the country now.

Scott Bursey (19:22)
Seth, that was a massive amount of fuel. Thank you for that. And we’ve got to know, what is the biggest advantage ADU investors have over traditional multifamily developers right now in your view?

Seth Phillips (19:37)
Well, it’s really simple. The magic formula in creating profit when you’re building, especially multi-family, is you start with a piece of dirt is how many things can you put on that piece of dirt? How many housing units can you put on it? So the value of the dirt is predicated by what you can put on the dirt.

Well, this is the cool part is with the stroke of a pen, it went from two to 20, but it has not actually changed the cost of the land at all yet. When we go out to look for a site,

We’re buying that dirt for the same price that we would have without these laws being in effect. So it all comes down to the cost of the land per door.

That’s just a figure that multifamily always do. It’s the cost of the unit per door, but ultimately it starts with the cost of the land per door. And magically now it just got literally 20 X’d. So that’s the key to the profit making potential.

Scott Bursey (20:53)
leveraging if I’m hearing you correctly.

Seth Phillips (20:56)
Correct.

Scott Bursey (20:58)
And Seth, if you could give us the play-by-play on what is the single most common design flaw you see new ADU builders make.

Seth Phillips (21:09)
Well, the first thing is that they probably might underestimate how much you could do. The more you can put there, the more profit potential there is for the property owner. Now, there’s of course two completely different kind of mindsets here because the single family homeowner building an ADU in back of their house is still planning on almost always living in that house.

So they look at it through a completely different lens because this is where they live, but they want to augment their living in whatever way they might have some older parents that they now could put in there instead of having them in an assisted living place, for instance, which the cost of assisted living now in Los Angeles is over $5,000 a month. Now you could build an ADU in your backyard and for some

Hopefully long period of time instead of paying $5,000 a month they have them an assisted living They could be living in your backyard Which is just also much better from a societal point of view as well But from a financial point of view, it’s it’s huge or you could rent it out ⁓ Or you can just use it as a nice Game room or man. She shed he shed and whatever all kinds of different practical

uses for that space. ⁓ And that’s really the exciting is that the use cases for the construction of ADUs is limitless really.

Scott Bursey (22:51)
I appreciate you highlighting that. Now let’s get into the weeds. What’s the biggest profit opportunity for pros in the next 12 months through your lens?

Seth Phillips (23:01)
Well, for the projects that we’re working on now is we’re putting together joint ventures with people because to make the most money, you need to build the most stuff. And this newest laws, two of them, one is specifically just for single family properties and the other one specifically for multifamily zone properties. But they now allow us to subdivide that lot.

either way into 10 separate lots and then on each one of those lots we can build up to 1750 square feet.

So under the single family one, you can only have one unit on each one of those lots. But on the multifamily zoning ones, you can have two units per lot. So what we have designed is specifically for that multifamily opportunity is we can subdivide by a piece of land. ⁓ Ideally, it’s got a single family home on it, a fixer upper, because what we do then is we just demo the

Now we’ve got a blank lot to work with and we can subdivide that lot into 10 lots and on each one of those lots we can build two units. So we have designed a three-story townhouse style duplex. The bottom level has got a small unit on it and then the main unit is the two floors above it and then we can even put a rooftop deck on top of that because

We’re talking about almost no setback requirements so we can literally fill the lot with structure. So that means no yard. But if we have a rooftop deck on top of each unit, we’ve basically got the yard back but with a bonus because now the yard’s got a view. So it’s super cool. And that way we can build the highest density you possibly can on the land because you’re not only getting the first level,

but you’re also then getting all the value of the air above it. So building three stories, you can do that without elevators, which have tremendous cost to a project. having a three story walk-up duplex and have 10 of them, so that’s 20 total units, that is a moneymaker. I mean, the rent potential on that would be each one of those duplex in a decent area of

Angeles could easily bring in $7,000 a month in income each duplex so you do that times 10

You got a lot of money So the the cash flow opportunities for something that big but you know, you’re talking about 17,000 square feet of construction. So that’s not a small project but as you and I were speaking about earlier now, we’ve got lenders out there and you know the hard money the private money has always been out there and interestingly as the

Regular interest rates went up a lot Hard money has actually gone down a little bit

not because of any governmental thing, just because there’s so many more private lenders now than they’re used to. So competition always gets you, you know, drives that kind of a downward thing in price. So interest rates actually went down a little bit on hard money, but they don’t have much leeway there. But what they do have leeway in is their loan to value.

And that has also changed much better, more more pro development because now we can get hard money that will be only require 15 % in cash of the total cost of the project. And that’s the cost of purchasing the land and the construction together. So really you can do a massive size project now with

somewhere anywhere between 500,000 to a million two. That’s really all you would need to build one of these massive projects where the total cost of them is going to be in the six million dollar range. You can finance almost all of it, which is really brings out, it makes it exciting opportunity.

Scott Bursey (27:45)
It most certainly does. And Seth, along those notes, besides long-term cash flow, what is the most underrated benefit of adding an ADU to an existing single-family asset in your eyes?

Seth Phillips (27:58)
Well, I’m going to answer that in two parts. For the ADU, yes. Besides them being a financial vehicle, as I said before, they’re really something that’s important from a societal point of view because, you know, back not that long ago, particularly in big cities, New York being an example, they built a lot of brownstones that were duplexes.

or multiple units in them, or designed for more than one family to live in them. So families lived in them and extended families lived in them.

neighborhoods were more neighborhoods beef because of that there was a stronger I think ⁓ dynamic to those kind of neighborhoods and as we moved into more and more exclusively single-family homes only that kind of in a way caused a physical separation in people

And then of course people also as transportation became faster and less expensive, family units just started to disperse more across the entire country. So.

there was a lot of benefits to having families closer together. And this product actually promotes that. It brings families closer together. It brings people closer together. So I think it is a good from a societal point of view. And another thing that is with this newest product that we get to build these duplexes. This is really important to me also from

the fact that I’m still a realtor and one of the things that just freaked me out recently and this was like two years ago now but I got a call I don’t do much retail sales anymore but I got a call from somebody that referred me a young couple that were looking to buy their first home and they’d already been pre-qualified through a lender for a million dollar purchase they had down payment money from ready to go from the parents

They had great jobs that paid really good. I mean, they were just a slam dunk. And like I said, I don’t usually do that much retail, but I figured, well, I’ll take them out. This will take me two, three weeks to find them a house. And that’ll be it. It’ll still be easy. ⁓ So we went out, found a house they like, made an offer. There was 50 offers on it. It got bid up. Didn’t get it. ⁓ wow. ⁓

took them out the next week, looked at some houses, found one they liked, put an offer in. Same thing happened. Only 30 other offers on that one. Next week, same thing. And all of a sudden I’m going, I’m freaking out. go, I can’t find a totally qualified first time buyer, a entry level house that they can buy?

for a million dollars, this is crazy. We’d passed that threshold because I hadn’t been paying much attention to it, as they said, in that retail world.

It just really got me thinking I I did get them a house because I basically went with the old house hack is we just found a total fixer upper then we got an FHA 203k loan that was the purchase plus some rehab money So they bought a less expensive house that needed a lot of fixing fixed it up themselves Now they have that over a million dollar house and they were able to get in that way but

I just realized that the percentage of young people that can actually just qualify to buy a single family home is becoming a smaller and smaller percentage every day. And there is a point where it would be so low.

that that would be really dangerous. I don’t know exactly what would happen to the market, but in one way I look at it as the real estate market is almost like this giant Ponzi scheme. Without having this bottom level coming in all the time, all the next levels can’t move up the pyramid. So if there’s no new money coming in on the bottom level of the housing game, what’s going to happen to the housing economy?

Well, I don’t know, but one thing, it can’t be good. It cannot be good. So this new product that we have to sell is also one of the oldest house hacks out there is that people that couldn’t afford to buy a first time home, what they could do is they could buy a duplex.

and the standard lenders out there, the Fannie and the Freddie Mac lenders, still do and have for a long time. They will, for a owner user, do lending on that duplex and they will credit that.

borrower the money from that second unit and apply that income towards their income qualifying for that which increases their buying power and So now we’ve got this modern new product that is a duplex

that will increase their buying power dramatically because they’ll be able to use that future income, doesn’t have to be rented, just the future income of it. And the lender will apply that towards their qualifying to get the loan to buy that. So this will help for time buyers get into the market. And I really, really believe that that is such an important thing that will help a lot of first time buyers get into the

And so I’m doubly excited about being able to sell that kind of product and hopefully that will really help a lot of people.

Scott Bursey (34:20)
Seth, this has been an amazing conversation. We’ve covered so much. Before we sign off, if our listeners want to follow your journey or collaborate with you, what’s the best way for them to reach you?

Seth Phillips (34:31)
Well, it’s a I got pretty simple numbers My email address is Seth. That’s S-E-T-H at my company name adu gold so it’s [email protected] so that’s very simple That’s my email address and I have my telephone number is (213) 784-4447 and I am in Los Angeles

And then my, as I said, my website, my company name is ADU gold. So my website is adugold.com.

Scott Bursey (35:12)
Seth, this has been an absolute masterclass. Thank you for joining us today.

Seth Phillips (35:17)
Thank you so much for having me and good luck everybody out there.

Scott Bursey (35:22)
And to our listeners, we appreciate each and every one of you. If you got value from today’s episode, please subscribe. We’ve got exceptional guests just like Seth who are making huge moves in the market. Until next time, keep your standards high and your vision clear. We’ll see you on the next episode, everyone.

Seth Phillips (35:38)
Ciao!